The Pound Reclaims Ground Lost to the Euro and Dollar

- GBP bounces off recent lows
- Amidst Feb. 2022 Bank of England rate hike expectations
- Market mood, Brexit pose as potential risks

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A rejuvenated bid has pushed the British Pound above its post-Bank of England lows as investors lock sights on a February rate rise.

Investors bought Sterling into the Tuesday session judging that the rapid repricing for future interest rate rises at the Bank of England was nearing completion and current exchange rates are more in keeping with an expectation for a February hike.

"Positioning still favours bullish strategies on the GBP," says Roberto Mialich, FX Strategist at UniCredit Bank in Milan.

The Pound to Euro exchange rate retraced losses from last Friday's low at 1.1635 to go back above 1.17 while the Pound to Dollar exchange rate retraced the previous week's decline to 1.3425 to test 1.3572.

The Pound is the biggest loser amongst the world's largest currencies when screened over the course of the past month, courtesy of the Bank's surprisingly dovish turn last Thursday, but a look at the currency's performance on November 08 suggests there are some willing to dip their toes back into the market:

Above: GBP outperformed all besides the NZD on Nov. 08.

• Reference rates at publication:
  GBP-EUR: 1.1703 \ GBP-USD: 1.3565
• High street bank rates (indicative): 1.1475 \ 1.3285
• Payment specialist rates (indicative: 1.1644 \ 1.3497
• Find out about specialist rates, here
• Or, set up an exchange rate alert, here

Heading into last Thursday's Bank of England policy decision analysts warned were policy makers to swerve a hike the Pound could come under pressure.

But few analysts and foreign exchange strategists were prepared for just how dovish the Bank would sound over the prospect for future hikes.

"What really surprised us from the BoE last week was the strength of their dovish tone. It wasn't only that they didn't hike, they were also dovish about future hikes," says Robert Wood, UK Economist at Bank of America.

"Our proprietary BoE mood indicator, based on natural language processing of BoE minutes and which we update here, backs up our subjective impression. It fell back to the least hawkish since May," says Robert Wood, UK Economist at Bank of America," adds Wood.

Should the Pound stabilise from here it would suggest the market has rebalanced itself away from a 2021 hike to a February 2022 move, which money markets now price as being a +100% likelihood.

The odds of a December rate hike have now fallen back to just below 50%.

For foreign exchange markets the bottom line is the Bank will still likely raise interest rates ahead of a number of other G10 central banks, notably the European Central Bank and the U.S. Federal Reserve, allowing for some rate support against the Euro and Dollar.

"In the last two months of the year, we however see the prospect of imminent tightening (we think the 15bp rate increase should come in December) to help GBP recover its post-BoE losses," says Francesco Pesole, FX Strategist at ING Bank.

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Juan Prada, FX Strategist at Barclays says he anticipates the Pound to be better supported from here out.

"GBP sagged after the BoE defied market expectation of a 15bp rate hike. The 7-2 decision to hold rates unchanged shook global markets, even spilling over to several EMs where rates-paying interest took a breather," says Prada in a weekly foreign exchange briefing note.

Economists at Barclays say the Bank's "dovish turn" seems to have been the result of a more subdued economic growth outlook.

The Bank lowered its 2021 growth forecast to 6.7% from the 8.5% forecast in August. However, the 2022 GDP forecast is lifted from 2.3% to 2.9% while 2023's forecast is lowered to 1.1% from 1.3% perviously.

But inflation is anticipated to remain well above the 2.0% target over coming months and the Bank has indicated it stands ready to act by raising interest rates as a result.

Bank of England Chief Economist Huw Pill told business leaders on Friday Nov. 05 that he expects the pace of wage inflation in the UK to exceed that of both the U.S. and the eurozone.

"Measures of underlying wage growth in the U.S. and the euro area remain at or below pre-pandemic levels,” said Pill. "In the UK, that is now beginning to exceed and is still on an upward trend relative to pre-Covid levels."

Above: UK job vacancies are at a record high says the ONS.

Wage inflation is widely held to be one driver of inflation a central bank can address - as opposed to externally generated inflation - suggesting Pill will soon lend his vote to a rate hike having opted to maintain the status quo in November.

"Inflation worries remain, making a rate hike a 'when not an if,' the actual timing of lift-off is likely to be data dependent," says Barclays' Prada.

Some economists had warned that raising rates in November would be too early and could risk hampering a fragile economic rebound.

Accusations of a 'policy mistake' would however be expected to fade were the Bank to push back the timing of the first hike.

"A more measured hiking path reduces the risk of premature tightening, supportive of growth recovery. To the extent that inflation is proven transitory, the latest rate decision could reduce the chance of a policy error," says Prada.

Such a view could in fact prove supportive of Sterling exchange rate valuations over a medium-term horizon.

Barclays had recommended selling GBP/USD on November 02 and saw their target reached ahead of the Federal Reserve and Bank of England meetings.

They say volatility in GBP should remain elevated but "we expect limited further downside," says Prada.

Josh Nye, a senior economist at RBC, says the Bank of England will still act "conventionally" by raising interest rates to fight inflation, in the near future.

"We now look for hikes in December and February but think market pricing for Bank Rate to hit 1% by the end of next year looks too high," says Nye.

Secure a retail exchange rate that is between 3-5% stronger than offered by leading banks, learn more.

While the Pound could find support from expectations for higher rates at the Bank of England over coming months, we remind readers there other moving parts to be aware of:

1) The broader market. Sterling has a 'high beta' i.e. it goes up against the Dollar, Euro, Yen and Franc when global stock markets are rising and falls when the opposite is true.

For now investors are in a bullish mood and this is supporting the Pound, but a major risk would be a concerted market selloff.

2) Brexit is a concern. 2021 has brought with it a welcome break from Brexit anxieties. But, the EU and UK are still struggling to sort out issues regarding Northern Ireland.

As we noted here, the issue is rising as a potential headwind for the currency and could limit upside potential in the near term.

The EU and UK's chief negotiators will again meet this week and we look forward to Friday's update.

The Telegraph reported on Monday the UK is willing to unilaterally override elements of the Northern Ireland protocol in order to remove burdens of trade within the United Kingdom.

Speculation as to how the EU might respond is a key source of uncertainty for the future of UK trade and the Pound.